The Mint: The “Peril” Through the Eyes of a FED Head

11/12/2010 Portland, Oregon – Pop in your mints…

We left off Wednesday wondering just what a good Central Banker is to do when faced with the supposed "Peril" of deflation? If you missed Wednesday's Mint, please take a moment to review it at the link below as it will greatly help your understanding of what follows:

The "Peril" Through the Eyes of a FED Head - Part I

For a brief refresher, Dr. James Bullard, the President and CEO of the St. Louis FED, published a research paper cleverly titled Seven Faces of "The Peril". Instead of reading the paper, we summed it up here in this handy cliff notes version:

"Deflation is bad, we'll end up like Japan, which must be bad, too. Therefore, we need inflation…I mean, we need the economy to grow! What should we big shots at the FED do to accomplish this? We could 1) Deny that it is happening and wait for inflation…I mean, the economy to improve on its own, 2) Assume that interest rates are simply stable and 0% is the right rate for the outrageous amount of money we have printed that is just refinancing old debts and not creating inflation…I mean new debts, 3) Do what we did in 2003 and take rates to 1.0 to 1.5% and hope for the best, 4) Freak everyone out and increase rates and hope that inflation…oops, there I go again! I mean that the economy improves, 5) Imitate the Bank of England that has somehow survived 314 years and never lowered their rate below 2% and again, hope that works, 6) Hope the government spends themselves to the brink of insolvency like some EU member nations have done, 7) Buy up US Treasury bonds and give counterfeit money to the government and hope that works!"

And now, the moment you have certainly wasted all of Veteran's Day waiting for arrives. Dr. Bullard in his brilliant academic voice, concludes, to everyone's astonishment, that buying up US Treasury Bonds in exchange for counterfeit money is the best way to avoid the "Peril" of deflation that surely awaits us. What an epiphany! I can't believe that in the history of the world no one has thought of counterfeiting money to pay off debts that would otherwise need to be defaulted upon! Thanks for enlightening us, Dr. Bullard.

Unfortunately, Dr. Bullard is simply giving a different name (Quantitative Easing aka "QE") to the age old trick of debauching the currency. Do they really get paid to come up with this nonsense? But let's go easy on Dr. Bullard and his associates. Should we really expect intelligent, real world answers from these people? They are simply salesmen looking for ways to sell the use of dollars as a medium for indirect exchange on an ever-increasing basis. The world is increasingly turning to other mediums of exchange. It is that simple. This is the "Peril" that the Yen has faced for a long time. On balance, people want fewer dollars than everyone thought. Nothing more. There you have it, fellow taxpayer. Mystery solved. Case closed.

Your author experienced a similar "Peril" one summer while helping a friend to promote what we assume is a now defunct soft drink called "Surge". Whether or not it was ever "funct", we have our doubts. Nonetheless, there were all sorts of outlandish attempts at various events, concerts, etc. to give out free samples. While at first there were many takers, there was always a point where you literally couldn't give this putrid stuff away. This is what the low interest, low inflation rate phenomenon in the US dollar system is telling us. On the margins, the dollar's popularity as a medium of exchange is diminishing. Increasing quantities will not change this fact. Just ask the makers of "Surge" cola or Gideon Gono, the Zimbabwean Central Bank Governor, how their experiments of increasing production in the face of diminishing demand are going.

Surge Surplus

People, we need to condition ourselves to see changes in relative values. This will help us see through the noise that runs through nominal values. Generally, the self interested human would like to see a higher RELATIVE value for the things he or she possesses at the moment and a lower relative value for the things that he or she wishes to acquire. Only charitable intentions or inexplicable phenomena such as the US income tax code would cause a person to purposefully incur a loss in trade.

So which do you prefer, inflation or deflation? The answer, if we are trained to look at relative rather than nominal values, should be that IT DOESN'T MATTER! That answer will change, of course, if you are a government who taxes income or capital gains in terms of nominal increases. Under a deflationary scenario, the government and its dependents would be the ones who stand to lose a collective fortune. This is the true "Peril" that the likes of Dr. Bullard are afraid of. It is also nature's cure for big government, with the helpful side effect of eliminating mismanaged currencies, so naturally the FED will fight this duel with deflation to the death of the dollar as a viable currency. They have no choice.

Have a great weekend and Stay Fresh!

David Mint